What Is the Stakeholder Theory?

Stakeholder theory is an ethics and management theory that states businesses must create value for all stakeholders to find success. Stakeholders are those with an interest in an operation, such as employees, customers or owners. Under this theory, companies emphasize corporate social responsibility over profits based on values, ethics and morals.

What Is Stakeholder Theory?

Would you rather work for a company that cares about you or a company that only cares about profit? Of course, any organization must ensure it makes money, but according to the stakeholder theory, investors and stockholders aren’t the only stakeholders that matter.

Employees are vital stakeholders, too. And they have changed the way they view work in recent years. For instance, Gen Z and millennial employees want to work for companies that align with their values and offer a positive societal and environmental impact. In fact, nearly 2 in 5 said they rejected a job based on personal ethics related to these factors. These are critical issues for companies to consider if they want to retain top employees.

So, what is the stakeholder theory, and what does it have to do with corporate social responsibility? The stakeholder theory claims that stakeholders’ needs and wants should matter if a company wants to succeed. We’ll discuss this theory in more depth, including how it impacts businesses, and what organizations can do today to make positive change.

Stakeholder Theory: What It Means

Stakeholder theory states that company leaders must understand and account for all company stakeholders to:

Optimize critical relationships
Improve efficiency
Focus on company values and ethics
Emphasize social responsibility (over profit)

In other words, stakeholder theory addresses the values, morals and ethics that leaders use to make things better when managing stakeholders and their involvement with an organization or project.

Many disciplines rely on stakeholder theory, including corporate social responsibility or business ethics.

What Are Stakeholders?

In business, a stakeholder is any person with an interest in an organization or project. A company has both internal and external stakeholders.

Internal stakeholders may include:

Employees
Managers or leaders
Owners

External stakeholders may include:

Customers
Creditors
Shareholders
Suppliers
Governments
Society

Stakeholder Theory vs. Shareholder Theory

While stakeholder theory and shareholder theory both focus on stakeholders, they involve different approaches toward stakeholder management.

Economist Milton Friedman’s shareholder theory proposes that shareholders (a type of stakeholder) should be an organization's priority only because of the financial support they provide. Professor R. Edward Freeman’s stakeholder theory says stakeholders are essential to widen an organization's focus, creating a more socially aware stakeholder management approach.

Friedman’s theory focuses solely on increasing shareholder value. Alternatively, Freeman’s theory concerns itself with creating value for all stakeholders so that they show continued support and interest.

Example of Stakeholder Theory in Action

Let’s imagine that a shoe company called Light Bright Shoes recently decided to go public.

The shareholders hope the stock values will rise, and Light Bright Shoes wants to satisfy shareholders who have invested time and money into the project. If we followed the shareholder theory, this would be enough. However, the stakeholder theory states that those investors are only part of the group that deserves the company’s attention.

Employees: At Light Bright Shoes, employees are also meaningful stakeholders. Without them, the operation would cease to exist. Employees at this company want fair pay, safe working conditions and a friendly work environment. If Light Bright Shoes can’t meet these expectations, the business will struggle with employee turnover and a weak reputation as an employer.

Customers and the community: Customers are essential stakeholders for Light Bright Shoes because satisfied customers lead to more sales. Creating fashionable, comfortable and affordable shoes, for example, will help customers realize that this company cares about their interests. Further, Light Bright Shoes must ensure its operation doesn’t disrupt or damage the surrounding community.

Suppliers: Light Bright Shoes’ suppliers are also extremely important stakeholders because they provide the resources necessary for workers to make products. Treating suppliers and vendors that share the company’s core business values fairly sustains ethical business practices and creates positive community relationships. If the suppliers don’t share the same values, Light Bright Shoes should cut ties to maintain corporate social responsibility.

Benefits of Stakeholder Theory

Stakeholder theory can encourage positive reactions and decision-making, leading to better returns for stakeholders (including shareholders).

For example, employers who view employees as valuable stakeholders will likely have an easier time motivating those employees to perform well and produce high-quality work. This may lead to higher production volumes and improved quality, both of which could lead to happier customers. Happier customers usually mean business growth and increased sales, which benefits all other stakeholders in various ways.

From the lens of a project manager, stakeholder theory is beneficial because it treats everyone involved in the project as valuable participants that will positively impact the finished results.

Drawbacks of Stakeholder Theory

Some opponents of the stakeholder theory claim that the interests of various stakeholders cannot accurately balance against each other. The reason for this is that stakeholders come from such a wide range of backgrounds and groups.

Pleasing all stakeholders is likely unattainable, especially since organizations naturally view some stakeholders and their needs as more important than others. This creates inequality, making stakeholder theory's benefits challenging to obtain.

Further, some stakeholders are more involved in decision-making than others. Those with more power can create influence, which may make others feel like they can’t obtain what they need or want.

How to Apply Stakeholder Theory

Stakeholder theory suggests that a company must develop relationships and generate value for each stakeholder.

In the modern age, corporate social responsibility is often tied to this objective because understanding stakeholders’ views and concerns on key issues allows for more meaningful relationships. Additionally, including these perspectives in the company’s overall strategy creates accountability in critical social areas and directly benefits the local community (and society).

Applying stakeholder theory through this lens helps organizations develop best practices that help their business thrive, create long-term goals focused on social responsibility and benefit all stakeholders effectively.

Discover Who Your Stakeholders Are

Start applying stakeholder theory by first identifying the company’s stakeholders. An easy way to go about this is by considering the organization’s functions and who impacts those functions. Remember to keep a broad perspective when doing this because external stakeholders, like the government or creditors, may be easy to forget.

Understand Your Impact

Once you know who the stakeholders are, it is easier to consider how impactful the company is on various levels.

Assessing the business's strategy, including objectives, current projects and long-term outlooks, gives a better understanding of how different business components affect each stakeholder. Additionally, reviewing business goals while applying stakeholder theory can identify ways one outcome may impact multiple stakeholders simultaneously, so remember to consider the big picture.

Reevaluate Your Processes

Applying this theory helps businesses understand their operations better, but weaknesses may appear in this evaluation. Consider these shortcomings and what changes may help improve or create efficiency without sacrificing morals and ethics. In this assessment, remember to consider the needs of all stakeholders (not just those with the most power).

Final Thoughts

The stakeholder theory suggests that understanding and accounting for all stakeholders leads to a stronger business. A strong business has more success and profits over time.

Stakeholder theory isn’t without its drawbacks, but companies operating through this lens may perform better or survive longer simply because of stakeholder support. Stakeholders that feel valued are more likely to care about the operation.

While it is virtually impossible to please all stakeholders all the time, working toward this goal shows that companies put people above profits alone.

Transforming a company with stakeholder theory in mind doesn’t happen overnight. Unless leaders built the operation with this perspective, some likely stakeholders have unmet needs. Luckily, with some reflection and operation assessment, companies can improve.

Top Takeaways